Topic 2. Risk and Risk Management Bus 200 Introduction to Risk Management and Insurance Jin Park.

Topic 2. Risk and Risk Management

Bus 200Introduction to Risk Management and Insurance

Jin Park

Overview

Terminology Risk Perils, Hazards ERM, IRM

Risk Management process

Terminology Risk

Deviation from expectation Worse than expected Better than expected

Uncertainty concerning a loss Uncertainty Loss (cf. Loss exposure)

Pure vs Speculative Fundamental vs Particular Systematic vs Nonsystematic (Diversifiable) Objective vs Subjective

Terminology Pure Risk

Loss or no loss

Fire Risk management

& Insurance

Speculative Risk Loss or gain

No loss/gain Investment Finance

Enterprise Risk Management deals with managing both risks in a firm

Terminology

Perils (Immediate) Causes of loss

Hazards Physical hazards Moral hazards Morale hazards

Risk Management Risk management

A systematic process for managing (pure) risks faced by an individual or organization.

Pre-loss risk management Should prepare for potential loss in the

economical way possible Post-loss risk management

Survival of the organization Continuation of operation Stability of earnings

Risk Management Process

Identify risks or exposures to loss Evaluate risks or exposures to loss Identify and select risk

management techniques Implement and monitor

Identify Risks Organization

Property Liability Business income Death or disability of

key persons Job-related injuries or

disease Fraud, dishonesty,

crime International

operation

Individual Property Liability Premature death or

disability Unemployment Sickness Liability

Identify Risks Physical inspection Questionnaire Financial statement analysis Flowchart Contract analysis Statistical analysis of past losses

Risk management information system (RMIS)

Evaluate Risks

Risk management matrix Frequency Severity

High

High

Low

Low

Frequency

Severity

Evaluate Risks

Risk mapping

High

High

Low

Low

Frequency

Severity

Identify and select RM techniques Risk avoidance Risk retention (Risk assumption)

Self-insured Captive

Risk reduction (control) Loss prevention – frequency Loss reduction – severity

Risk transfer Insurance Non-insurance

Example: Sprinkler, Hold-harmless agreement, ignorance, safety education, smoke alarm, deductible, warm-up, rent

Identify and select RM techniques

Risk mapping Critical issue tolerance boundary or

risk-tolerance boundary Prioritize risks

Implement and Monitor

Are techniques implemented correct?

If not, …

Insurance Advantages

Uncertainty is reduced

Insurers can provide. their expertise such as loss control services.

Insurance premium is tax-deductible.

Insurance proceeds are tax-free.

Disadvantages Insurance premium

may be a major cost. Moral and morale

hazards may be created.

Time and effort have to be spent.

Insurance may not be renewed.

Others

CAT bonds Forward/Future Swaps Options Securitizations CDO, CMO, CBO, CLO

Enterprise risk management Integrated risk management The process of planning, leading and

controlling the activities of an organization to minimize the effects of risk on earnings and capital

A holistic approach to risks faced by a firm Risk management has to be integrated among

various players in a firm Requires a (strategic) risk management policy Needs support from the top level of a firm

The Three Faces of Risk Management

Although most companies have their bases covered should they meet with fire, theft or flood, such hazards represent …

Explains about ERM allows organizations to examine all the risks they

face measure the potential impact of those risks on the

long-term viability of the company take the appropriate steps to manage or mitigate

those risks. "The goal is to ensure the continuity of the

enterprise“ "This is an opportunity to get to know your risks

better than your competitors. It can also leave you in a position to be able to take on more risk — the type of risk that can help improve company performance."

An example of an electronics manufacturer

Top Cops Explains about CRO Explains about ERM

"We're building the capability internally to identify all risks, analyze and quantify them, and then determine the optimum means of mitigating, absorbing, or transferring them.”

“When that's done, we will decide on an ongoing basis which risks to keep and which to transfer. Then we can effect the transfer through our trading desks, financial markets, insurance carriers, integrated risk policies, OTC [over-the-counter] transactions, or a contractual transfer to another party entirely.“

other CROs are working closely with insurance brokers, accounting firms, and risk management consultants to lead the way,

Illinois Power

The Risk Register a comprehensive risk-assessment

system a formal process that identifies,

quantifies and categorizes the risks facing Illinois Power, develops cost-effective methods to control them and positions the company to achieve its stated goals

Illinois Power

Benefits of the Risk Register aware of the catastrophic risks aware of the fact that its pre-loss risk

management was not adequate developed a more efficient and

effective post-loss risk management program

built risk-related database

Illinois Power IDENTIFYING THE RISKS

regardless of insurability CONSIDERING CONTROL TECHNIQUES

disregarding cost or appropriateness of any method

SELECTING RISK CONTROLS subjected to a reasonableness test and a

thorough economic evaluation IMPLEMENTATION MONITORING

UPS

Why small firms? Why not large firms? Why not pharmaceutical firms? Lessons

"Use more than one delivery company.“ "August is a good time for a strike,

because there is not a lot of stuff being done."

Domino effects

???

Next- Loss ExposuresETTI: Chapter 1, pp. 16 – 18 ETTI: Chapter 8, pp. 162 – 164, 170 – 172, 173 – 176 ETTI: Chapter 9, pp. 180 - 203  1. Business continuity planning: Preparing for the worst ,

KPMG Insiders, June 10, 20022. U.S. firms underestimate IT risks , Insurance Day, June 14,

20023. Prudent Man with a Plan, CFO Magazine, June 18, 2002.4. Warning: A batman cape won’t help you fly , New York

Times, March 5, 1997.5. Jury awards $12 million in voice-mail hang-up , Chicago

Tribune, April 3, 2003.6. $36 million awarded to heirs of 2 killed in freak accident ,

Chicago Tribune, date unknown.